Margins And Guidance Are Keys
Earnings estimates for 2023 are too high—this is about as consensus as a view gets. The tough part is figuring out how far estimates need to fall and how much of a headwind that haircut will be for stocks as they try to dig their way out of this bear market.
The consensus S&P 500 earnings per share estimate for 2023 is currently $240, down from $250 at the end of June. Our recently lowered forecast stands at $230, down from $235 last month. The lowered forecast assumes inflation pressures ease enough in 2023 to help support margins in the second half of next year. That doesn’t change the fact that margins have to come down and recession risk will remain high as the inflation fight continues.
We acknowledge that margins need to come down further after only coming in about a half point so far. Wages have been rising amid ongoing labor shortages. Supply chain disruptions related to China’s zero-COVID-19 policy persist. Retailers still have inventory problems. Companies were essentially overearning during the pandemic, so some mean reversion still needs to occur. Some of these pressures have started to ease, but lower commodity prices and slightly looser labor markets have had limited impact thus far.
Bottom line, we would look for another half point or so to come out of operating margins over the next two to three quarters, bringing them down to pre-pandemic highs. But look for revenue growth and progress on inflation throughout 2023 to enable S&P 500 companies to at least match 2022 earnings—now tracking to $223—in 2023.
Conclusion
Companies almost always beat expectations because the bar is lowered enough for them to step over it. Third quarter should be no exception.
The key, as always, will be guidance. Estimates will surely come down to reflect slower growth, higher inflation, and the stronger dollar. But given companies’ demonstrated ability to manage rising costs in recent quarters and the boost that inflation provides to the revenue line, we don’t expect estimates to collapse.
No doubt there will be hits and misses—there already have been with disappointing August results from FedEx paired with better-than-expected results from the likes of JPMorgan, PepsiCo, and UnitedHealth. But overall, we would expect modest estimate cuts to be received positively by markets, supported by lower valuations and depressed investor sentiment.
Much of this bear market has been driven by lower valuations, with the forward price-to-earnings ratio (P/E) for the S&P 500 Index having dropped from over 21 at the start of the year to below 16 currently. Looking ahead, although an eventual Federal Reserve pause (likely a Q1 2023 event) and a lower 10-year Treasury yield (3.5% rather than 4%) could prop up valuations, stocks will likely take their cues from earnings in the near term. Any earnings gains in coming quarters will be hard earned and minimal, but likely well received.
Jeffrey Buchbinder is chief equity strategist at LPL Financial.